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The immediate causes of failures: beliefs of executives, auditors, lawyers, investment and commercial bankers, and corporate directors that they could default on their duties without bearing the consequences

Compounded by the failure of government to discipline the individual failures

Cases are winding their way through the courts

Will enforcement of the existing laws remedy the problem?

Mixed signs so far:

Enron’s auditor is out of business but its law firm is not

Qualified people reluctant to serve as the directors; nominating committees reluctant to choose technically qualified but unknown people for boards

More non-employees on audit and compensation committees; but we do not yet know if they would serve the interests of others any better

Stock option grant rates slowed down in 2002, yet the rapid rise in the compensation of senior executives continues

Stiff resistance to Donaldson’s proposals from business and Wall Street

The charge the American Association of Public Accountants gave to a Special Committee on Accounting Terminology in April 1909

to collate and arrange accounting words and phrases and show in connection with each the varying usages to which they are put. … This committee will not attempt to determine the correct or even the preferable usage where more than one is in existence (Zeff 1971, p. 112).

In 1918, a memorandum on auditing procedures, prepared by the American Institute of Accountants, and approved by the Federal Trade Commission (FTC), and originally published in the Federal Reserve Bulletin, labeled “A Tentative Proposal Submitted by the Federal Reserve Board for the Consideration of Banks, Bankers, and Banking Associations; Merchants, Manufacturers, and Associations of Manufacturers; Auditors, Accountants, and Associations of Accountants.”

The intent was to coordinate the evolution of norms, and not to impose a standard.

In 1918, the American Institute of Accountants appointed a Special Committee on Interest in Relation to Cost to address a lively controversy on imputed interest as part of the cost of production

The Committee’s recommendation against inclusion of imputed interest in cost of production, approved at the annual meeting of the Institute, does not become accepted as an accounting norm

The Institute appoints a special committee on the standardization of accounting procedure “to consider all questions of procedure brought before it, and to make recommendations from time to time on vexed questions in the hope that ultimately there may be established something approaching uniformity of procedure throughout the country”

The charge suggests facilitation to form norms, not legislation of standards. During its eleven-year tenure (1918-1929), the Committee produced six reports, and none was submitted for an official stamp of approval of the membership

The absence of authoritative standards of accounting did not mean that the world of accounting had less order in the early twentieth century than in the early twenty-first

Active mechanisms the accountants used to identify the norms of their profession

Journal of Accountancy and the CPA Journal served as forums for active, even feisty debates on accounting and auditing; a function largely abandoned by the accounting journals over the past quarter century when authoritative standards pushed the norms out

During 1920-29, the Librarian of the Institute issued 33 “special bulletins” on topics referred to them, without the authority of the Institute.

In 1931, the Institute published a 126-page book Accounting Terminology, a compilation of accounting terms and their definitions as a matter of advice, not authority.

Throughout the 1920s and into 1930s, a committee of the Institute worked in close cooperation with a committee of Robert Morris Associates, an organization of bank loan officers, to respond to inquiries submitted to them.

The U.K. (and the European Union) protect individual privacy by legislated standards monitored and enforced by government

The U.S. allows the privacy policies in e-commerce to evolve as norms or conventions of e-commerce without legislated standards or a punitive enforcement mechanism

Jamal, Maier and Sunder’s (2005) compared the performance of these two regimes:

The frequency of email messages sent to those who do (and those who do not) give consent to receive such messages, is almost identical under the two regimes (Exhibit 2).

In providing timely notice of privacy policies and obtaining consent, the performance of the standards and enforcement regime of the U.K. is about the same as that of the evolutionary regime of the U.S. (Exhibit 3)

In the absence of legislated standards and their government enforcement, a market for web assurance services, including privacy assurance, has arisen in the U.S. but not in U.K.

Formal regulation does not provide protection from the extreme behavior of a few websites

This is consistent with Enron, WorldCom, Fannie Mae, and other companies being mired in accounting scandals in the most extensively regulated financial reporting environment

Privacy has fared no better in the U.K. than in the unregulated U.S. e-commerce environment

Legal scholarship and practice is careful in recognizing the limits of the efficacy of written rules

When it is not possible to write a rule that will improve the state of affairs compared to a judgment-based system, the law leaves the judgment in place

When a judge asks the jury to determine if the accused is guilty beyond reasonable doubt, lay jurors would want to know how much doubt is reasonable: ten percent, two percent, or one percent?

Law does not attempt to codify answers to such questions

People who write and practice law understand all too well the consequences of clarifying such questions would be even less desirable than the consequences of leaving the answers to the best judgment, even of lay people

The SEC and the U.S. Congress refuse to clarify the definition of insider trading beyond “trading on non-public information”

Again, the consequences of clarification are even less desirable than the consequences of leaving such matters to judgment.

Setting up accounting institutions such as the FASB and the IASB, whose sole function is to issue new accounting rules, has contributed to the tendency to write standards which are “generally accepted” only by fiat of authority

Wisdom from law, abolish the rule making monopolies in various jurisdictions, and introduce competition among rule makers with each financial reporting jurisdiction in order to address this problem (Dye and Sunder 2001, Sunder 2002).

The legal requirement of an independent audit of publicly-held firms blocks efficient functioning of a market for audit services

If independent audit were not a legal requirement, firms with sufficient confidence in their accounts and in their prospects would spend the money to hire reputable independent auditors to convince their shareholders about their transparency and good prospects

Firms without such confidence will not find it worthwhile to hire auditors

Investors, presented with reports with and without auditor certificates will have to make their own risk assessments and price the securities accordingly

Without government regulation, a market for certification or audit services would develop analogous to the U.S. market for web services in e-commerce

Evolution and functioning of an audit certification service for online comic book and other auctions on eBay

Instead of allowing such a market to develop endogenously, the SEC requires all firms to have their reports audited

PCAOB has been set up recently to specify the standards by which the auditing must be carried out

Adding watchmen to look after watchmen does not help

The extensive regulation of audit practice has been accompanied by commoditization of the audit, and contributed to extensive auditing failures of recent years